Let’s assume a simple economy where money comes in the form of monetary base issued by the government / central bank machine, and in just sufficient quantities to induce citizens to spend at a rate that brings full employment. No interest is paid to holders of monetary base. We’ll also assume there are no commercial banks: i.e. citizens bank with the central bank.
The “no commercial banks” assumption might sound odd, but in fact when lending to government or paying taxes, final settlement is always done in base money, not commercial bank created money. So that assumption is not unrealistic.
Now let’s assume government wants to make a public sector investment.
Government could attract funds from citizens with a larger than normal stock of money (I’ll call them “hoarders”) and offer them interest. But unfortunately that wouldn’t work. Reason is that the investment spending would increase demand and we’ve already assumed full employment. Thus the extra spending would be inflationary.
So even if government funded the investment with borrowed money, it would still have to raise taxes so as to ameliorate inflation. (A nice illustration of a point often made by MMTers, namely that the purpose of tax is not to fund government, but to control inflation. Actually that MMT point is a bit of an exaggeration, but it’s a nice sort of “exaggeration to make point”.)
Anyway, getting back to the point that government borrowing does not reduce taxation, you could of course argue that hoarders who “lend” to government will then be short of their “rainy day” stock of money and will thus save more so as re-stock with rainy day money. And indeed, if they did save in that way, that would depress demand, which would make room for the extra demand coming from government investment spending.
However, when lending to government, lenders do not really lose access to their savings in that they can sell their government bonds anytime for cash. And assuming any individual hoarder’s need to sell bonds to meet an unexpected need for cash occurs at a random point in time (which it almost certainly does), then the need for that money by one hoarder will be balanced by another hoarder’s desire to buy government debt.
In short, the process whereby governments supposedly borrow to fund public investments is a farce: they can go through the motions of borrowing to fund investments, but the reality is that those investments are funded out of tax.
The only exception to the above argument comes to the extent that government borrowing is funded by foreigners. On the other had if we assume that citizens of country X buy a dollar of debt issued by country Y for every dollar of debt issued by country X and bought by citizens of country Y, then the above argument holds.
But even to the extent that the latter “X and Y” point does not apply, the argument in the above paragraphs, if it is correct, is an almighty dent in the whole idea that government borrowing is a good idea.
P.S. (same day). In Britain, as in other countries, households with anything near average incomes and average net assets don’t normally buy or sell government bonds directly. But in Britain they can easily do so indirectly via “National Savings and Investments”. NSI has about £100bn of depositors money invested in government stock, and has about 20 million depositors.